Relocating in retirement is relatively common, especially to a state with nicer weather, lower property taxes, and low (or no) state income tax. Determining your tax domicile is crucial for retirees looking to optimize their financial situation. But establishing domicile for tax-saving purposes during retirement can be a complex and confusing process, especially if the state you reside in isn’t technically your “domicile.”
The IRS has strict rules surrounding the establishment of domicile, but doing so correctly can help reduce your tax liability and maximize your retirement savings. We’ll walk you through determining your domicile and the steps you can take to claim domicile to save on taxes properly.
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Residence vs. Domicile: Understanding the Difference
You might think of the home—or residence—where you spend most of your time as your domicile. But in reality, “residence” is where you stay, and “domicile” is your permanent home—essentially where you call home. The concept of domicile is crucial in determining your state of domicile for tax purposes. You might dwell in multiple homes and consequently have residency in various places, but legally, you can have only one domicile. This can be especially tricky for anyone who splits their time between multiple homes.
Though the exact definition varies from state to state, “domicile” generally refers to a person’s permanent home and the place they intend to return to after time away. For tax purposes, it is where a person is considered to be a resident and is, therefore, subject to the tax laws of that jurisdiction. A person’s domicile is determined by their physical presence, the location of their personal and financial connections, and intentions.
How To Establish Domicile in a New State
Domicile can be determined by your true intent to live in a particular state. Once again, these factors vary by state, but purpose can typically be substantiated by the following:
Physical Presence and State Residency Requirements
This refers to the amount of time you spend in a particular location. If you live in one place for most of the year, this is likely your domicile. To claim domicile in a new location, you’ll need to establish residency in that state. State residency requirements typically mandate that you live there for at least 183 days per year to be considered a resident for tax purposes.
Personal Connections
This includes things like where your family lives, where your kids go to school, where you are registered to vote, and where you have a driver’s license. To fully establish domicile in your new state, you’ll need to cut ties with your old state by changing your driver’s license, voter registration, and other legal documents.
Financial Connections
This covers where your bank accounts are located, where you own property, and where your investments are held. This means closing bank accounts in your old state and updating or transferring all legal documents to your new state.
Intentions
This refers to your plans for the future in your new state. To prove that you have established domicile, it’s essential to document your intentions. This might include writing a letter to your previous state of domicile, declaring that you have changed your legal residency, or signing a Declaration of Domicile outlining your upcoming plans in the new state. This legal document is often used as the first step toward establishing legal residence in your new state.
And here’s where things could get tricky. You can cut ties, list intentions, and swear you’ll never go back. But your domicile will remain until you fully establish another one. In other words, your lifestyle must reflect a permanent change of residence.
Can You Be a Resident of Two States?
While it’s possible to have residency in multiple states, you can only have one tax domicile. This distinction is crucial for tax purposes and can affect your overall tax liability.
If you’re unsure about the process of claiming domicile or the potential tax implications, it’s a good idea to seek professional advice from a tax expert or real estate attorney. They can best help you understand the process and ensure that you take the proper steps.
The Impacts of Claiming Tax Domicile for Savings
Relocating to a state with no state income tax might seem the obvious choice. It is, after all, a great way to maximize your retirement savings! Additionally, some states offer special tax incentives for retirement plan distributions, pension payments, and Social Security payments.
But when considering a new state to establish domicile—specifically for tax-saving purposes—don’t neglect the specifics of property, sales, and estate taxes, too. Further, some states might not tax wages but do tax interest and dividends.
Claiming domicile can be complex and not without potential risks involved. For example, if you cannot entirely cut ties with your old state, you may still be subject to its tax laws. Establishing and proving your domicile to the satisfaction of the tax authorities can be difficult and time-consuming, too. To be successful, it’s crucial to be thorough and document everything.
The Bottom Line: Maximizing Retirement Savings Through Tax Domicile
Claiming domicile for tax-saving purposes during retirement can be a clever way to reduce your tax liability and maximize your retirement savings. However, it is vital to understand the process and the potential risks. Exercise your due diligence when it comes to each state’s rules. You want to avoid ending up in any worst-case scenarios with multiple states of residency claiming that you owe them income taxes. By following the proper steps to establish residency (and seeking professional advice when needed), you’ll be prepared to reap the benefits of your relocation!
If you’re considering relocating in retirement or splitting time between two states, where you intend to claim domicile should be discussed with your financial advisor for tax-planning purposes. If you need help navigating these waters, schedule your 15-minute introduction call with our Uncommon Cents Investing team today!
